Written by

Dr. Ira Kalish

Published

December 13, 2012

Chinese economic growth is finally accelerating after experiencing a substantial slowdown during the past year. A rise in government-funded investment helped to offset the considerable weakness in exports to Europe. Interestingly, exports to other geographies have actually improved. In October, overall exports were up 11 percent from a year earlier, significantly exceeding expectations. This, in turn, contributed to a 9.6 percent increase in industrial production in October, offering the prospect of stronger GDP growth in the fourth quarter. In November, a private sector purchasing manager’s index for manufacturing moved into positive territory for the first time since July and indicated the fastest rate of growth in the sector in more than a year. In October, retail sales growth accelerated from September, suggesting that the consumer sector is improving as well. Thus, it appears that China is on the mend.

Moreover, with prices up a mere 1.7 percent in October compared to a year earlier, consumer price inflation decelerated substantially, reaching the lowest rate of inflation in 33 months. This means the central bank has considerable wiggle room if it chooses to further ease monetary policy in order to stimulate the economy.

However, although growth is showing signs of revival, China still faces some challenges. For example, foreign direct investment (FDI) into China declined in October for the 11th time in the last 12 months. Slowing growth in China, weakness in the global economy, a rising currency, rising wages, and political uncertainty are all likely reasons for the deceleration of inbound investment. For the first 10 months of 2012, inbound FDI was down 3.5 percent from 2011. Outbound investment from China, however, increased strongly. In the first 10 months of the year, outbound FDI was up 25.8 percent from 2011. This suggests that Chinese companies are actively searching for resources and for new opportunities around the world. China’s higher-valued currency means that foreign assets are relatively cheaper. Recent weakness in commodity prices probably makes commodity-production resources cheaper as well.

Challenges for new leadership

Turnover in China’s political leadership raises questions about the likely path of government policy and how the new leadership is likely to tackle longer-term economic challenges. Interestingly, outgoing Chinese President Hu Jintao recently said that China should plan to double per capita GDP from 2010 to 2020; this goal may be realistic if Chinese economic growth doesn’t slow down. This will likely require significant reforms aimed at maintaining long-term growth in the face of challenging demographics. Hu hinted at reforms by calling for the private sector to have “equal access to factors of production.” Hu also called for improving the ability to innovate and for a boost to domestic demand. Equal access for the private sector is significant. Today, state-run businesses have favorable terms of credit, thus frequently limiting credit to private-sector businesses, especially smaller ones that must pay very high rates of interest in the informal credit sector. Reformers want to free-up market interest rates that are currently set by the central bank and allow all borrowers to compete freely for credit. Hu’s evident support for this measure could presage considerable reform of credit markets. However, doing so will likely have the effect of reducing the profit margins of state-run businesses.

Turnover in China’s political leadership raises questions about the likely path of government policy and how the new leadership is likely to tackle longer-term economic challenges.

Another issue is the necessity of shifting away from export-led growth toward consumer-led growth. Rising wages are already helping to make this happen. For example, in the past three years, the wages of China’s migrant workers increased 56 percent. Yet, exporters have mostly not passed on this cost increase to their customers. The prices of US imports from China rose only 4 percent in the last three years. Absent huge productivity gains, this pattern cannot be sustained indefinitely as it would ultimately mean disappearing profit margins. Rather, export growth will likely decline, and with big wage increases, consumer spending in China should grow faster. Market-opening reforms can help to accelerate this change in China’s economic structure.